How to Raise Money from Strategic Investors

Financings for startups are tricky. In the five year period leading up to 2010, approximately 91.6% of all tech startups in the US were self-funded or bootstrapped, 8.1% were Angel-backed and just 0.3% were VC-funded*. This means that the great majority of tech startups during this period required knowledge of self-capitalization techniques. 

(* https://www.eqjournal.org/?p=4119). 

I met with Pierre Bisaillon recently, the charming founder of ProjectSpeaker.com, to talk about financing. Afterwards, I drew the primitive business model shown above for his new enterprise. (Disclosure, I am a client of ProjectSpeaker.com and have created a profile for myself as a keynote speaker on his platform.)

ProjectSpeaker.com is, in my view, going to be the airbnb.com of the speaking industry– it will tie together what is now a “mom and pop” industry. ProjectSpeaker.com allows speakers and event planners to create profiles for free and it uses its “brain” to match the interests of event planners in terms of the types of speakers they want for their “shows” with the abilities, rates and locations of speakers. ProjectSpeaker.com will be able to push notifications and recommendations to event planners that will become more intelligent as the platform evolves– i.e., as it is populated on both sides of their model.

I believe it will also evolve to allow vendors and event planers to create profiles too and then, by introducing a friend/fan/follower model along with updates, it will become a true social network as well. Enterprises that create communities of interest* will be much more sustainable than those that are simple websites narrowcasting a message to a selected audience.

(* For example, I joined https://www.resaas.com/brucefirestone this week, a social network for real estate professionals. If they play their cards right they should create real competition for MLS systems and sites like https://www.loopnet.com/).

To demonstrate how important building a community around your new enterprise is, imagine if you and I decided to launch a twitter clone which would not be an impossibly difficult task. But it would take a Herculean effort to convince 232 million active monthly twitter users to switch.

The other thing I would do is allow new users to log in with their facebook, twitter or linkedin user IDs and passwords and I would permit all updates made on the new platform to show up in users’ twitter feeds, facebook status updates and linkedin updates and vice versa (assuming those services agree to integrate). I believe it was a huge mistake for Google+ to follow facebook’s example and create a gated universe. What makes twitter so powerful (and in my view a service likely to sustain itself over the long haul) is that it is outward facing– anyone can see my updates on @profbruce or @quantum_entity. This holds people to a higher standard of behavior in many ways and can make each micro post more important and relevant.

Anyway, Pierre asked me, “How should ProjectSpeaker.com raise money?”

Financings are usually sourced three ways–

1. sweat equity from the founder(s)

2. third party equity in the form of a friends/family/fool round of financing or, in more limited numbers, from angels, super angels and VCs

3. debt in all its many manifestations including founder and director contributions in the form of shareholder loans or directors’ contributions.

But in Things Every Tech Startup Needs to Know about Self-Capitalization, I wrote about alternative ways to raise money via bootstrap capital which I consider a new form of capital since it is usually the least expensive way and often the fastest way to raise money.

One form of bootstrap capital is sourced from strategic investors– people, groups or organizations that have a vested interest in your success; folks who will often finance your new enterprise at very low cost. How do you find those people/groups/organizations? Well, you ask, “Who benefits?”

In the above model, ProjectSpeaker.com receives no revenues from either their clients (event planners) or suppliers (keynote speakers) but they do receive money from another layer of supplier– the vendors in this industry. ProjectSpeaker.com expects to generates millions of dollars in income for vendors, companies who supply the industry with hotels, venues/meeting centers/convention halls, travel, ground transportation/taxis/limousines, food and beverage, catering, DJs, AV and other technology, security, video production, promotional items, party rental equipment and furnishings, tradeshow booths and equipment, marketing and promotion, media/PR, tour operators/sightseeing, restaurants, shops, printing, museums, magicians, comedians, dancers, volunteers, charities/not-for-profits, and the thousand other things event planners may require or ask to participate. ProjectSpeaker.com will take x% of those revenues to sustain itself.

These are the strategic investors who have a special interest in ProjectSpeaker.com’s success. So let’s say Pierre wants to raise $150,000 in an A-round. My first recommendation is to make it $200,000. I have an old fashioned view (unlike most banks, other lenders and funders)– give an entrepreneur slightly more* than s/he is asking for so they don’t get to the five yard line and fail. You don’t want them to almost score a touchdown.

(* Slightly more means $200k instead of $150k not $3m. Too much money is BAD for a startup– they almost certainly will not use it wisely and will lose their focus on clients, revenue generation and cost control which is a mistake. Tom Duxbury, a highly successful tech entrepreneur, mentor,  investor and now PhD student says, “One of the startups I was involved with raised $20 million in its first few weeks. Big mistake. Startups with too much capital get sloppy.”)

The second piece of advice is to not to go the equity route. Equity is expensive and often takes a very long time to raise. If Pierre goes the angel/VC route or does a friends/family/fool A-round, it may take him 6 or 9 months or even longer to pry money out of tight-fisted Aunt Polly or miserly angels and VCs*.

(* Fore more about Why VCs Don’t Buy Ideas or Invest in (Most) Startups, And Why Large Firms Aren’t Really Interested in Hearing from Entrepreneurs Either, please refer to: https://www.eqjournal.org/?p=4236.)

But if Pierre decides to go this way and ends by giving up say 10% of his equity for $200k and it turns out that ProjectSpeaker.com really is the airbnb.com of this industry, that $200k will have been an expensive mistake*. Remember there are only ten 10s in a hundred so keep your equity in your treasury as long as you can. It will simplify your corporate structure and keep the founder in control for the longterm.

(* Y-combinator’s airbnb.com is estimated to be worth $4b. 10% of that is $400m; that’s $400,000,000.)

I am not opposed to raising money from investors in all cases, I just want founders to be careful so they don’t sell too low and too often and then end up in the same position as one of my coaching clients who has built an incredibly valuable tech business (they produce middleware which runs virtually every data shop involved in trading stocks around the world) but only owns 18% of it and now his BOD wants to bring in another CEO to replace him.

So here is what I suggested instead–

a. identify 12 vendors who have a strategic interest in ProjectSpeaker.com

b. ask each of them to pay $50k upfront to be featured partners on the platform.

This would raise $600,000 if they all said “yes” but a success rate of 3 or 4 in 10 is more likely so this process should result in additional funding of around $200k.

Now what are the terms for this new funding?

Remember, they don’t get any equity. So their $50k contribution could be entirely a rights fee– funding that is non-repayable and non-recourse. It’s a form of advertising/sponsorship that gets them featured as preferred vendors on ProjectSpeaker.com. 

But part of their contribution could be repayable by ProjectSpeaker.com if Pierre wanted to sweeten the deal for the vendors. For example, half of the contribution could be repayable from royalties vendors would pay anyway. So assume a vendor generates $250,000 in business from the platform each year and has to pay ProjectSpeaker.com say $25k of that in the form of royalty which means ProjectSpeaker.com could repay the vendor half of their contribution in a year. That’s good in a way but it also severely curtails ProjectSpeaker.com’s ongoing cashflow– a significant percentage of the their revenues in their first year will be used to repay vendor contributions and will not be available to fund operations. So instead I suggested that they could repay these contributions at half that rate meaning it would take two years instead of one leaving the balance for use as working capital.

You can alter this model in myriad ways by playing with this formula. But it is by far one of the cheapest and quickest forms of capitalization and it has the added benefit of bringing powerful allies into the mix who have a strong incentive to steer their own ecosystem of event planners towards the ProjectSpeaker.com platform.

Prof Bruce

Postscript:

Once a shark tastes blood in the water, there is no stopping him or her! Here’s a note from Pierre on a meeting with a possible strategic investor:

Bruce,

I met this morning with Bob Edges (name changed, Ed), founder/CEO of REIT CO (company name changed, Ed) to discuss participating in our funding round. After hearing the details of ProjectSpeaker.com, Bob informed me that in addition to managing assets of some high profile hotels, they own a large number of them as well. Bob feels ProjectSpeaker.com would be a good fit as a strategic partnership for their hotel group and will be putting me together with his colleagues who are tasked with exactly these kind of agreements. In fact, they carry a budget specifically for these types of deals.

Their latest deal was with another Ottawa company that created a light bulb with a wi-fi transmitter built into it which essentially replaces existing bulbs and delivers hi-speed wi-fi as well as light. They are often in Ottawa because of this current relationship.

I would not have even pitched a strategic partnership to Bob had you not educated me about it via your experiences.

By the way, after this morning’s meeting, I’m even more convinced that strategic investments/partnerships are a viable way to generate funding and may even alleviate some or all of the need for outside equity/angel/VC investments.

Cheers, Pierre